Fund Fees - Beware
It's an undisputed fact; on average, Mutual Funds in the USA and Unit and Investment Trusts in the UK underperform the rest of the stock market. For every managed fund that beats the market, another underperforms. After fees are deducted, the average managed fund turns out to be a loser.
Every dog has its day, however, and it's often the case that last year's loser becomes this year's winner, before returning to being a loser again.
And this is the source of an investing scandal. Fund managers know that they'll get lucky some years, regardless of how poor their stock picking skills might be. It's just like throwing a pair of dice once a year. Sometimes you're going to score 10, 11 or 12. Every time you get a high score, you don't say, "hey, wasn't I lucky". Instead you say, "Hey, it's time to charge a fat performance fee."
How Fund Managers Get Rich
Creaming Off Performance Fees
Consider the "Lucky Fund" which has $200 million of investors' money in it. One year the stock market rises by 10 percent but the "Lucky Fund" does better, rising by 15 percent. By the end of the year the fund has gained $30 million to reach a value of $130 million. $20 million of this would have come from merely tracking the stock market. $10 million is so-called "outperformance". The manager then takes a 25 percent "outperformance" fee - i.e. $2.5 million. (This of course comes on top of other fees.)
The following year, the stock market rises by another 10 percent but the "Lucky Fund" rises by only 5 percent. Does the manager return last year's bonus to compensate for this year's poor performance? Of course not silly, it's already been spent on a new yacht.
Some investors don't seem to mind paying extra fees in "the good years", forgetting they don't get them returned in "the bad years". The net effect is that their investments grow by much less than they would have if they had placed their funds in a low-fee, index-tracker fund.
Warren Buffett advises non-expert investors to put their money in index-tracker funds - this way their savings will at least keep pace with the general stock market without lining the pockets of undeserving money-managers. If you're looking for an index-tracker, choose a fund with a reputable company that charges the lowest fees.
Alternatively, you can search for a fund manager who charges only when successful. DUNN, whose founder we discuss elsewhere operates such a policy. They charge no management fees whatsoever - they are purely performance based and past losses must be recouped before further performance fees are charged.
Unfortunately, DUNN only caters to corporate investors and very wealthy private investors. DUNN's fee structure is, however, a model crying out to be adopted by the wider investment industry.